Taxpayers Reject Idea of Losing Deduction for Health Insurance

A proposal to levy a tax on health care insurance meets a chilly response from Capitol Hill, the Bush administration, AHIP, and pollsters. What a surprise.

December 1, 2005

John Carroll

Should health insurance be a taxed benefit? According to the President's Advisory Panel on Federal Tax Reform, the answer is yes.

Led by two former senators, Connie Mack III and John Breaux, the panel set out to repeat the kind of tax simplification program laid out in 1986 under President Reagan. Their job was to make it easier to navigate the code and get rid of the Alternative Minimum Tax that was bearing down on growing numbers of the middle class, without running up the federal deficit in the process.

Health care insurance was intended to shoulder part of that burden. The panel recommended that plans worth more than $5,000 per person and $11,500 per family — the national average — would be subject to taxation. Individuals buying their own health care plans could deduct costs up to those national averages.

The panel noted that there are now a variety of ways for people to use pre-tax dollars to buy health insurance. Companies can discount the cost of insurance and there are flexible spending accounts and new health savings accounts to help spread availability of the pre-tax advantages. And with 2002's health care bill expected to be about $1.5 trillion, tax benefits linked to health care spending are expected to amount to $141 billion in fiscal 2006, equal to 12 percent of all federal spending. Even after adjusting that cost for inflation, the cost has tripled since the 1986 tax reform effort — largely due to the insurance benefits available to the under-65 set from their jobs.

"Tax benefits related to health care tend to benefit upper-income households more than lower-income households," the panel reported. "That is true not only because a health-care-related deduction or exclusion is worth more to a higher-income taxpayer in a progressive income tax system, but also because higher-income people are more likely to have insurance. In 2004, families earning more than $100,000 received 27 percent of the tax benefits for health spending."

Tax preferences for health insurance led people to buy more of it, and the added insurance coverage in turn drove health care spending, the panel concluded. Cutting tax preferences, they said, could cut health care spending 5 percent to 20 percent. Moreover, those extra tax subsidies for the affluent, said the panel, could have the effect of driving up premiums for the working poor, leading to a higher number of people going without insurance altogether.

The panel recommended that companies keep their tax benefit for insurance and that workers should be able to buy a base amount of insurance in pre-tax dollars. Individuals could buy insurance in pre-tax dollars up to the national average. Anything over that would be taxed.

Even, before the commission made its recommendations, though, America's Health Insurance Plans was polling on the issue. AHIP came back with some big numbers likely to intimidate any elected official looking to slice the tax advantages linked to health coverage. The pollsters stuck with a bipartisan crowd in three key primary states — Iowa, New Hampshire, and South Carolina. Better than 90 percent rejected the general idea of cutting back on tax advantages tied to plans. And the poll noted that a majority of voters saw any reduction in tax benefits as a likely way to add to the ranks of the uninsured.

"Voters are sending a strong message that they don't want the IRS coming between them and their health care," said Karen Ignagni, president of AHIP, before the panel's final recommendations.

Trade-offs rejected

"We asked questions that relate directly to what the panel ultimately recommended," says Whitfield Ayres, PhD, president of Ayres, McHenry & Associates, "and overwhelmingly, Democrat and Republican primary voters oppose the health care recommendation. More than 8 out of 10 Republican and Democratic caucus goers or primary voters (in those three states) oppose taxing benefits. And those voters are strongly opposed.

"We presented various tradeoffs as well. We asked them if they would agree to taxing health care benefits in return for lower overall tax rates and opposition remains at about two thirds of the group."

AHIP may have little actual work to do to stymie the proposal, though. In the days after the recommendations came up, the feedback from Capitol Hill was notably chilly.

No one in the Bush administration even endorsed the recommendations. Treasury Secretary John Snow limited his remarks to a vague assurance that the recommendations could make a foundation for a tax reform proposal. The proposals as a whole were gaining little traction in Congress — and not necessarily because of the health care provision. The commission suggested limiting the deduction available on home mortgages, stripping away the gains made by people who live in homes that are worth more than their state's average price. That had real estate agents and the mortgage banking industry offering some trenchant responses.

Scornful senator

And not a lot of elected representatives found a lot to cheer about either.

"The panel wants to slap some lipstick on the pig and call it a day," said South Carolina Sen. Jim DeMint, a Republican, who went on to say that the proposals amounted to nothing more than a few band-aids for a badly wounded tax code. For many conservatives, the commission missed out on two of their favorite tax reform notions: a flat tax or a national tax based on consumption.

Ayres summarized the flat response in a few words: "It sank like a stone."

The tax proposal wasn't the only issue being tracked by the health insurance industry on Capitol Hill. The Senate Finance Committee's decision to cut a $10 billion stabilization fund intended to bolster managed care organizations' return to Medicare was drawing frowns from AHIP as well.

The fund was devised to encourage MCOs to offer Medicare PPOs in areas that would be difficult to operate in profitably. Also, health plans looked to the federal government to stand by its promise to make this new Medicare program a success. A host of plans pulled out of Medicare several years ago when it became financially unfeasible to continue.

Threatening to pull the plug on the stabilization fund is "upsetting the apple cart with a program that has barely got off the ground," says AHIP's Ghose.

But health plans aren't about to give up without a fight on this one. And with the House savings plan focusing on cuts in Medicaid instead of Medicare, AHIP believes it has a good shot at coming out on top of this issue.

John Carroll, a freelance writer living near Austin, Texas, has been a contributing editor of Managed Care for four years.